The Bankruptcy Code grants a trustee (or a debtor in possession) certain “avoidance” powers to recover payments to creditors made shortly before a bankruptcy filing where the payment gave the creditor more than other, similarly situated, creditors would receive through the bankruptcy process.

In a recent case in the United States Bankruptcy Court for the Western District of Michigan (the “Court”), the Court considered whether a payment made by a Chapter 7 debtor to her son in advance of the debtor’s bankruptcy filing was “preferential” and thus subject to recovery by the Chapter 7 trustee.

Prior to the debtor’s bankruptcy filing, the debtor’s son loaned money to the debtor which he secured by obtaining a security interest in her car. He perfected the security interest by signing his name as the “first secured party” on the certificate of title.

The debtor later decided to sell the car and asked her son to prepare the certificate of title to deliver to a buyer. He signed the title under the legend that reads “Release of First Lien” on August 12, 2012, before the debtor had located a buyer for the car.

Later that month, while in Atlanta, the debtor found a purchaser for the car. At that time her son mailed the certificate of title to the debtor in Atlanta and the sale was completed. The proceeds from the sale were then deposited into a bank account for her son’s benefit. The debtor subsequently filed for Chapter 7 bankruptcy protection.

The trustee brought a preference action against the debtor’s son, alleging that the payment of the proceeds from the vehicle sale was avoidable. In advance of trial, the parties stipulated that the payment satisfied the prima facie elements of a preference action. All that was left to decide, therefore, was whether the debtor’s son had a valid defense that the payment constituted a “contemporaneous exchange” under section 547(g) of the Bankruptcy Code.

To establish a contemporaneous exchange defense, the debtor’s son was required to prove by a preponderance of the evidence that the transfer was:

  • intended by the debtor and the creditor to or for whose benefit such transfer was made to be a contemporaneous exchange for new value given to the debtor; and
  • in fact a substantially contemporaneous exchange . . .

After considering the evidence and weighing the credibility of the witnesses, the Court ruled in the defendant’s favor.

First, the Court determined that the debtor and her son intended the payment and release of security interest to be a contemporaneous exchange, and also found that the exchange - despite the certificate execution and sale being several weeks apart - was substantially contemporaneous.

The Court explained that, while the debtor’s son signed the certificate of title on August 12, he did not deliver the document until his mother had, in fact, found a buyer. This meant that the defendant, “as a practical matter, postponed the effectiveness of his signature until delivery to his mother.”

According to the Court, the debtor’s son also, as required by the contemporaneous exchange defense, provided “new value” to the debtor by relinquishing the security interest. The Court noted that its decision was consistent with the policies behind the contemporaneous exchange defense, which prevent avoidance of a debtor’s payment “if the payment is offset by the debtor’s receipt of new value.”

As this case demonstrates, the contemporaneous exchange for new value defense can be a flexible one. The defense depends on proving, among other things, that both parties intended the exchange to be contemporaneous, which can be difficult. But as demonstrated by the Court in this case, courts will look past certain technicalities - such as the date when a document is signed - to try to determine the parties’ true intent.